How Does a Pending Foreclosure or Short Sale Affect Financial Aid?

How do we answer the question “Do you own your home” on financial
aid forms when we are in pre-foreclosure? We are not yet in active
foreclosure, but are several years in arrears on our mortgage as we
are significantly underwater on our loans and have been unsuccessful
so far in getting a satisfactory modification. To that end, we just
retained a bankruptcy attorney to expedite the process, and expect to
“forfeit” the house in the end either through a short sale or in
bankruptcy.
— P.G.

Need analysis formulas use a snapshot approach to evaluating
assets. Assets are reported on the FAFSA, PROFILE and other financial
aid forms based on the status in effect on the date the financial aid
application forms are filed. So until the foreclosure is finalized,
the home must still be reported as an asset.

(The Free Application for Federal Student Aid (FAFSA) ignores the net
worth of the family’s principal place of residence. Vacation homes and
other real estate must be reported as an asset on the FAFSA, usually
as an investment asset. On the other hand, the family home must be
reported as an asset on the CSS Financial Aid PROFILE form and some
institutional financial aid forms.)

Applicants cannot anticipate a future change in the status of the
asset, not even if foreclosure is imminent. The lender does not take
legal possession of the asset until the foreclosure is
complete. Applicants also cannot update the assets listed on the FAFSA
after the application is filed, even if the status of the asset
changes the day after the application is filed.

But a home that is in pre-foreclosure is unlikely to have much of an
impact on eligibility for need-based aid. Colleges that consider the
family home as a reportable asset always base their assessment on the
net worth of the asset. The net worth is the market value of the asset
minus any debt that is secured by the asset. The net worth of the
asset is also reduced by the amount of any liens against the asset. A
home that is in foreclosure or a pending short sale usually has little
or no home equity, and so will not have much of an impact on the
expected family contribution (EFC).

However, a foreclosure can affect eligibility for the Parent PLUS
loan. PLUS loan borrowers must not have an adverse credit history,
which is defined as a current delinquency of 90 or more days on any
debt or a five-year look-back for certain derogatory events in the
credit history. The derogatory events include bankruptcy, foreclosure,
repossession, tax lien, wage garnishment or default determination.

Once the foreclosure is complete, it will prevent the parents from
borrowing from the PLUS loan program for five years. (The initiation
of the foreclosure process is normally treated as evidence of an
adverse credit history. But the PLUS loan denial can be appealed based
on extenuating circumstances if the family obtains a loan modification
or short sale before the foreclosure process is complete.) Including
the mortgage in a chapter 7, 11 or 12 bankruptcy discharge will also
affect eligibility for the PLUS loan. A chapter 13 bankruptcy does not
affect PLUS loan eligibility.

The definition of an adverse credit history does not include short
sales. So a family facing foreclosure may prefer to have a short sale
to preserve eligibility for the PLUS loan. A deed in lieu of
foreclosure is treated the same as a foreclosure, unless it was
provided as part of a short sale.

If a dependent student’s parents are denied a Parent PLUS loan because
of an adverse credit history, the student will be eligible for the
higher unsubsidized Stafford loan limits available to independent
students. These loan limits provide an additional $4,000 or $5,000 per
year in unsubsidized Stafford loan eligibility, depending on the year
in school. Some parents prefer to have their student qualify for the
higher unsubsidized Stafford loan limits, since the Stafford loan is a
student loan, not a parent loan. However, the increased unsubsidized
Stafford loan limits might not be enough if the student is enrolled at
a high-cost college.